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Should you buy Westpac?

One of Australia’s largest banks, Westpac’s (ASX: WBC) shares have rallied since May 2012 as a low interest rate environment has caused investors to seek out high yielding stocks to deliver better returns.

The defensive nature of bank stocks has also attracted investors from around the globe in light of volatile economic conditions and consumer and business uncertainty. In such an environment, each of the banks have climbed substantially since May 2012. For instance, ANZ (ASX: ANZ) and NAB (ASX: NAB) have climbed 55% and 57%, respectively, whilst Commonwealth Bank’s (ASX: CBA) 47% increase saw it overtake BHP Billiton (ASX: BHP) as Australia’s largest company by market capitalisation.

In that time, Westpac’s shares have recognised the largest gain. Valued at around $20 per share back in May 2012, the shares reached a high of $34.79 in May this year and have since fallen back to $32.85 – still amounting to an incredible 64% leap. With that in mind, is Westpac still a buy?

Growth potential

Westpac is reportedly the frontrunner to take over Lloyds Banking Group’s Australian business, which is valued at $10 billion and consists of a car leasing business ($6.5 billion) and a corporate loan book. Westpac is willing to pay more for the business as it believes it can integrate Lloyds’ businesses with its own.

Based on the potential for growth however, ANZ is your better bet due to its heavy focus on expanding into the Asian market.

Market share

Westpac’s market share in the home loans market has diminished due to its higher mortgage rate, which is currently sitting at 5.98%. Although the company is recognising a greater premium at this rate, it is concerning that its market share fell by 0.7% in the 12 months to July.

In addition, Westpac has admitted that it is behind its competitors in investing in new technologies. The technology that NAB and Commonwealth Bank have both invested in is designed to improve customer service and convenience for the long term, which would likely win over more customers.

Where to in the long run?

Westpac’s shares could very well continue to climb in the coming weeks or months as investors continue to look for yields instead of depositing their money in low-returning term deposits. However, interest rates will inevitably rise and we will likely see share prices contract or, at the very least, slow down in the long term.

In comparison, there are still plenty of companies trading at attractive prices that stand a better chance of delivering outstanding returns for years to come.

Foolish takeaway

There is no doubt that Westpac is a quality company, however based on its current valuation, it looks very unlikely to deliver market-beating returns in the long run.

For investors who think that they have missed the boat on the banks, there are still plenty of opportunities available (many of which are a lot smaller than the banks and hence may have more room to run)! For instance, two of Australia’s most promising small companies are still flying under the radar. Discover these two exciting ASX investments in our brand-new special FREE report, “2 Small Cap Superstars”. Click here now, it’s free!

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Motley Fool contributor Ryan Newman does not own shares in any of the companies mentioned in this article.

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